How Groupon lost its edge

NEW YORK — Only a few months ago, Groupon was the Internet's next great thing. Business media christened it the fastest-growing company ever. Copycats sprang up. And investors salivated over the prospect of Groupon going public.

Today, the startup that pioneered online daily deals for coupons is an example of how fast an Internet darling can fall.

Groupon is discounting its expectations for the IPO that in June was valued as high as $25 billion. In a regulatory filing Friday, the company said that it expects a valuation that is less than half that at between $10.1 billion and $11.4 billion.

It's the latest twist for Groupon's IPO, which was one of the most anticipated offerings this year. In June, after Groupon filed for the offering, the SEC raised concerns about the way it counts revenue. Then the stock market plunged.

Now Groupon faces concerns about the viability of its daily deals business model. The novelty of online coupons is wearing off. Some merchants are complaining that they are losing money — and customers — on the deals. And competitors are swarming the marketplace.

"Groupon is a disaster," says Sucharita Mulpuru, a Forrester Research analyst. "It's a shill that's going to be exposed pretty soon."

Groupon shows what can happen when a startup experiences steroidal growth in an unproven industry. To its defenders, the Chicago company is a victim of its success, its stumbles emblematic of a business in infancy. After all, Groupon has hordes of fans who rave about the company's deals and its liberal refund policy. And some merchants see the company as a way to get much-need exposure.

But critics say the issues Groupon is facing are symptomatic of something more troubling: questionable accounting, an overvalued business model and an industry that is turning into the digital equivalent of junk mail.

Groupon, which was started in 2008 by computer programmer Andrew Mason, a Northwestern University graduate, is expected to go public Nov. 4. The company could not comment for this report due to the quiet period for its IPO, during which time company officials are barred by regulators from discussing anything about the firm.

By 2010, Groupon was in nearly 100 cities and 25 countries. Groupon's staff ballooned to nearly 10,000. Mason was on his way to becoming the next tech billionaire. But Groupon began facing a growing perception that its business was unstable.

The online deal space was getting jammed with competitors, like LivingSocial, Amazon.com and Google. They are among the many copycats who are attempting to do what Groupon does. Big merchants are also running their own daily deals online.

Good deal for whom?

At the same time competition was building, merchants began to do the cruel math on the daily deals.

Restaurants offering $50 of food for just $25 collect only $12.50 — not even enough to cover the cost of the food. Some businesses also complain that the deals for new customers anger longtime patrons. Others say that the bargains attract high-maintenance types who don't turn into loyal customers.

"Your restaurants are full packed with people who aren't making you any money," says Paul Evans, a Kansas marketing executive who advises clients against using Groupon.

Then came concerns about how Groupon accounted for its revenue.

Groupon roughly splits the money it collects from customers with merchants. But in a regulatory filing, Groupon reported all of its gross billings as revenue. Standard accounting principles dictate that Groupon should have used net revenue — the amount it keeps after paying the merchant.

For example, Groupon reported $1.52 billion in revenue for the first half of 2011. But after the SEC questioned it, Groupon in late September submitted new documents that showed that net revenue in the first half of this year was actually $688 million. Groupon was overstating its revenue by roughly half.

The company has its supporters. Groupon has been funded by such venture capital heavyweights as Andreessen Horowitz, firm of Netscape founder Marc Andreessen. Andreessen declined to comment, but in an August essay in the Wall Street Journal, he wrote that companies like Groupon would "eat the retail marketing industry."

"We are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swaths of the economy," he wrote.